What is a breakout level?
We have always noticed stocks moving in a trading range for long. This at times does get frustrating. Upside limit of this range is always a strong resistance level for the stock. This is where a stock witnesses heavy selling pressure/profit booking and finds it difficult to move above a certain level.
On the downside or the lower trading range of the stock is where selling pressure eases and stock starts to see buying start to come in. To explain this further, below is an example.
Lets take the chart of Shoppers stop. Chart shown below is from September 2009 through September 2010. As we can see since November 2009 till May 2010, almost for 7 months, stock was moving in a range of 320 to 400. It continued to see selling pressure as it neared 410 levels and buying interest resumed as it neared 320-330 levels.
Finally on May 28th 2010, it gave a closing above 410 levels closing 6% higher or at 424 that day. Stock witnessed huge volumes, which indicated that fresh money was entering the stock. Stock went into a consolidation mode after this breakout. Stocks consolidating after a breakout is very important for the future movement of a stock. This indicates, that yes, after a breakout, stock is not witnessing much of selling pressure or profit booking and is managing to trade above its resistance level of 410. On 1st of june Nifty corrected by 110 points, but Shoppers stop managed to hold onto its support levels and closed 4rs lower at 424.
This was a strong indication of a breakout. Stock was not witnessing selling pressure and was poised for an up-move in coming days.
We usually notice that stocks give a breakout by moving 8-10% on a particular day, but the next day or in coming days, they correct and revert back to the previous levels. To avoid entering such stocks and booking losses, one needs to wait for some consolidation in a stock after a breakout and then enter it. Shoppers stop had a fabulous rally after this breakout from 420 it rallied and made a high of 711. A return of 73% in 2 months.
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